YELLEN ON MAKING SURE NO FINANCIAL INSTITUTIONS ARE TOO BIG TO FAIL

"We are completely committed with trying to deal with too-big-to-fail. We have put in place numerous steps and have more in the works that will strengthen these institutions, force them to hold a great deal of additional capital and reduce odds of failure."

YELLEN ON OTHER POTENTIAL SOURCES OF SYSTEMIC RISK

"Systemic risk in the financial system is not purely a question of too-big-to-fail institutions... We could have systemic risk if a large number of smaller institutions are hit for some reason."

YELLEN ON HEADWINDS AND FISCAL POLICY

"I do agree with the view that there are substantial headwinds facing the economy. One example would be that we see in surveys of households that their expectations about their future finances and growth in their real incomes is exceptionally depressed and I think that's a factor that is depressing spending. We see in the housing market were we had some progress but it now looks like it's stalled... And fiscal policy has been a factor in my view holding back recovery and that's what monetary policy has had to counteract and that's in part why we've needed such an accommodative monetary policy… The economy is making progress… But to the extent that even when the economy gets back on track it doesn't mean that these headwinds will have completely disappeared…"

Janet Yellen's Q&A, the key points

Thanks to Reuters, here are some of Janet Yellen's most notable comments at the Senate banking committee today (highlights start here):

YELLEN ON THE OUTLOOK FOR ASSET PURCHASES

"Purchases would cease after October, but if there were to be some very significant change in the outlook that we see between now and October so that we lost confidence that the labor market will improve for some reason, or that inflation would move back up to 2 percent, then we would have to rethink that plan."

YELLEN ON LONGER-TERM PLAN FOR RATE RISES

"Even after we think the time has come to raise rates, we think it will be some considerable time before we move them back to historically normal levels... Of course we need to be cautious to make sure the economy continues to recover.""This is not a pre-set course. If we were to judge the conditions changed significantly, it's not locked in stone."

YELLEN ON WAGE INFLATION

"While rising compensation or wage growth is one sign that the labor market is healing, we are not even at the point where wages are rising at a pace that they could give rise to inflation. In fact real wages have been rising less rapidly than productivity growth; what we’ve seen is a shift in the distribution of national income away from labor and toward capital."There is some room there for faster growth in wages and for real wage gains before we need to worry that's creating an overall inflationary pressure for the economy. That's something we are watching closely."

YELLEN ON USING REPURCHASE OPERATIONS TO HELP CONTROL FUNDS RATE"

We've indicated that the main tool we will use is the interest rate we pay on overnight reserves. The overnight RP facility that you refer to I think of as a back-up tool that we will use to help us to control the federal funds rate, to improve our control over the federal funds rate. I think it's a very effective and useful tool. We have gleaned that from the initial testing that we've done. But as you mentioned, we do have concerns about allowing that facility to become too large or to play too prominent a role…"

YELLEN ON WHETHER CONGRESS SHOULD REQUIRE A FED BOARD SEAT BE FILLED BY A COMMUNITY BANKER

"I am very positive on the idea of having a community banker appointed to the board. That said, I don't support requiring it by legislation... That's a road that could go further in a direction that would worry me. If we're earmarking, we could end up earmarking each seat for particular kinds of expertise."

YELLEN ON LONG-TERM UNEMPLOYMENT

"While long-term unemployment remains at exceptionally high levels and is a grave concern, I do think we are seeing improvements as the job market is strengthening."

YELLEN ON TIMING OF RATE RISE

The Federal Open Market Committee will be looking at "maximum employment and price stability... There's no formula and no mechanical answer that I can give you about when the first rate hike will occur. It will depend on the progress of the economy and how we assess it based on a variety of indicators."

YELLEN ON ECONOMY, RATE HIKE OUTLOOK

"My reading at the present time is that the (Q1) GDP decline is largely due to factors I would judge to be transitory, and I do think that negative number substantially understates the momentum in the economy. Of course this is something we need to watch carefully and are doing so...."The Federal Reserve does need to be quite cautious with respect to monetary policy. We have in the past seen sort of false dawns, periods in which we thought growth would speed, pick up and the labor market would improve more quickly, and later events would prove those hopes to be unfortunately over-optimistic.

"We are watching very carefully. Especially when short-term overnight rates are at zero so we have no ability to lower them further, we need to be careful to make sure the economy is on a solid trajectory before we consider raising interest rates."

Fed warns biotech and social media stocks may be overvalued

Traders work on the floor of the New York Stock Exchange today. Photograph: JUSTIN LANE/EPA

The Federal Reserve has sent stock markets falling by warning that social media and biotechnology companies may be overvalued.

In its latest Monetary Policy Report, issued today, the Fed said that it doesn't believe overall equity markets are too optimistic. But it suggested that valuations in both sectors may have been driven too high.

Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.

Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of “reach for yield” behavior by some investors.

Most members of the FOMC believe the first interest rate rise will come in 2015, and the median prediction is that rates will be 1% by the end of next year, Yellen adds (that's just based on the latest projections - nothing new here)

Janet Yellen: there's no formula for when interest rates will rise

The Banking committee are pitching questions at Janet Yellen now, and the Fed chair showed some nifty footwork.

Asked when she thinks interest rates might rise, Yellen explained that the committee has given guidance that it will assess its progress towards its two mandates of price stability, and maximum employment.

There's no formula for when rates will rise - it depends on the progress of the economy, measured against a number of indicators.

And with a helpful smile, Yellen directs the committee to the FOMC's latest economic projections.

If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.

On Financial Stability:

The Committee recognizes that low interest rates may provide incentives for some investors to "reach for yield," and those actions could increase vulnerabilities in the financial system to adverse events.

While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk.

Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance.

So, in summary.....

Since the February Monetary Policy Report, further important progress has been made in restoring the economy to health and in strengthening the financial system.

Yet too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed. The Federal Reserve remains committed to employing all of its resources and tools to achieve its macroeconomic objectives and to foster a stronger and more resilient financial system.

In it, the Fed chair also outlines that US interest rates will remain well below historic levels for some considerable time:

We currently anticipate that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the federal funds rate below levels that the Committee views as normal in the longer run.

Janet Yellen: US recovery is incomplete

Just in -- Janet Yellen is telling Senators on the Banking Committee that America's economic recovery is incomplete.

And with wages stagnant, and the labour market still weak, loose monetary policy can still be justified for the foreseeable future.

That's the highlights from her prepared testimony, as her testimony begins.

Reuters has more details:

In a strong defense of the central bank's current stance, Yellen said that early signs of a pickup in inflation aren't enough for the Fed to accelerate its plans for raising interest rates, a move currently expected in the middle of next year.

That could change, with interest rates rising sooner and faster, if data show labor markets improving more quickly than expected, she said.But as it stands, "although the economy continues to improve, the recovery is not yet complete," Yellen said in semi-annual testimony before the Senate Banking Committee, repeating her focus on lagging labor force participation and weak wage growth as key to any conclusions about the economy's health.

"Too many Americans remain unemployed," Yellen said.Yellen presented a broad overview of an economy still in transition from the 2007-2009 economic crisis.

In an accompanying report, the Fed said its balance sheet would top out at $4.5 trillion when its bond-buying program ends in October, a sign of how much stimulus the central bank has had to unleash to support the economy.

These are Yellen's first comments since her press conference on June 18, which followed the latest FOMC meeting.

Since that meeting, we've gotten a bunch of economic data, headlined by the June jobs report. That report showed that non-farm payrolls expanded by 288,000 in June as the unemployment rate fell to 6.1%, its lowest level since September 2008.

They also suggest that Yellen may be asked about a New York Times preview, in which the Fed chair says she didn't anticipate the problems caused by the 2005 and 2006 housing bubble

Goldman Sachs bonus pool rises

Today's results also show that Goldman Sachs staff benefit from the jump in profits, with almost $4bn set aside for pay and bonuses for the last three months.

Goldman explains that the bonus pool has deepened, in line with the rise in profits. Here's the key section:

The accrual for compensation and benefits expenses (including salaries, estimated year-end discretionary compensation, amortization of equity awards and other items such as benefits) was $3.92 billion for the second quarter of 2014, 6% higher than the second quarter of 2013, reflecting an increase in net revenues.

The ratio of compensation and benefits to net revenues for the first half of 2014 was 43.0%, consistent with the first half of 2013. Total staff decreased 1% compared with the end of the first quarter of 2014.

Lloyd Blankfein: we're pleased with our performance

Goldman Sachs chairman Lloyd C. Blankfein says the company is "pleased with its results', given the "mixed operating conditions during the last three months.

Blankfein added:

“This performance was driven by the diversity, strength and breadth of our global client franchise. Good client activity in Investment Banking and Investment Management as well as a better environment for our Investing & Lending activities helped offset less favorable conditions for Institutional Client Services.”

Goldman's investment banking arm grew revenues by 15% compared with a year ago, and were 'broadly unchanged' compared with the first quarter.

The committee is concerned that the risks of misconduct in the financial markets is not being properly monitored by the Bank of England.

Memories of a recent meeting, in which BoE policymaker Paul Fisher said it wasn't the bank's job to look for evidence of misconduct, have not faded.

Mark Carney has gathered his thoughts, and launched a firm defence of the Bank's actions.

There will be changes in how markets run, and we are helping to drive that process internationally. It will cover how these market work, how Libor is set, how the foreign exchange rates are set (an issue covered this morning), Carney insists.

These reviews will have consequences, Carney insists. London is the centre of the financial world, and we need to ensure that it is trusted.

And the governor then reiterates that these reviews do not focus directly on the equities markets. Because:

Equity markets are the sole responsibility of the F <pause> C <pause> A.

How will forbearance change when rates rise?

Mark Garnier MP presses the Bank of England's representatives about the issue of forbearance – what will happen to highly stretched mortgage-holders and struggling indebted companies when interest rates rise?

The BoE argues that this is not a major threat to economic stability.

Continuing forbearance ad infinitum would not be consistent with either of the Bank's key objectives, Mark Carney said.

And Donald Kohn argues that "when interest rates rise, it will be the context of a strong economy".

Wages will be rising, rents will be rising, property prices will be rising, Kohn says, meaning that people who lose their jobs because their employer can't afford debt repayments should be able to find more work.

"Rising interest rates will be a good sign."

Martin Taylor (the former boss of Barclays), points out that it will be harder for lenders to extend the life of a mortgage, because people are already borrowing at longer timescale.

Andrew Bailey makes the same point -- pointing out that unusually long mortgages are already common in countries like Sweden.

If mortgages extend beyond when people's income falls off, we have a problem, Bailey warns.....

Carney defends ultra-low interest rates

My constituents have suffered losses because they bought these products, and now find that the cost of exiting them is high because of current monetary policy, Baker says. These businesses are hurting because bank rate is so low.

Carney won't accept this one. It is "hardly news" that there is a cost in signing up to a fixed interest rate if rates subsequently fall.

And he also reminds the committee of the big picture. If policymakers hadn't acted as they did since 2008, we could have seen the "wholesale collapse of the financial system, and this debate would be irrelevant".

Carney: UK housing market is biggest threat to recovery in the medium-term

Onto housing...and Mark Carney says that the UK housing market is the biggest risk to the durability of the recovery in the medium term.

The Bank's fear is that lenders become too reckless -- granting loans that are too risky, leading to too much indebtedness.

Carney explains that British people have a great record of repaying their mortgages, however deep their financial problems. That means they slash spending on everything else, hurting the wider economy.

His colleagues also weighed in:

BANK OF ENGLAND FPC'S TAYLOR - NOT SUSTAINABLE FOR HOUSE PRICES TO RISE FASTER THAN WAGES INDEFINITELY, BUT CAN CONTINUE FOR QUITE A LONG TIME

The Committee now asks about the Bank for International Settlement's warning that the international financial system is now dangerously fragile, and that central banks should rein in their ultra-loose policies.

Mark Carney looks unimpressed by BIS's intervention, saying its views are "interesting", but made in a vacuum.

BIS has no mandate, and isn't responsible to parliament, he point out. They are "outside the political reality".

Carney also suggests it would be "dangerous" to start aggressively tightening monetary policy now, at a time when global investors are already searching desperately for 'yield' (as the rates of returns from many safe-haven assets have fallen sharply).

Carney: Mansion House speech was meant to shake up the markets

Mark Carney says he was trying to stimulate more volatility last month, when he said that interest rates might rise sooner than the financial markets expected.

Asked by Jesse Norman whether the Mansion House speech was meant to "shake up" the markets, Carney replied "absolutely".

It was designed to make market participants more aware of the risks, the governor explains, adding:

We were concerned that markets were not reacting to a fairly long run of data that had been as expected, if not a little better, and there had not been a change in the prediction for the first rise in interest rates.

But then, Carney repeats that he doesn't know when rates will rise, and it will all depend on the data.

Donald Kohn, an external member of the Financial Policy Committee, throws his weight behind a time-varying leverage ratio.

He tells the committee explains that he'd be concerned if the leverage ratio couldn't be raised alongside the 'risk-weighted ratio' (another capital requirement).

But won't a time-varying leverage ratio encourage Central Banks to indulge in herding behaviour, Tyrie replies? He's worried that central bankers will all misread the state of the financial markets -- potentially keeping leverage ratios too low, and then "running off a cliff" when a crisis begins.

The Treasury points out that UK inflation is still below the 2%, just...

A HM Treasury Spokesperson says:

“The government’s long term economic plan is working, with today marking the 6th consecutive month that inflation has been below the Bank of England’s two per cent target.

But the effects of the great recession are still being felt and so we have taken continued action to help with the cost of living, including cutting income tax, freezing fuel duty and reducing the costs of childcare. The job is not yet done and the biggest risk to the recovery would be abandoning the plan that’s delivering a brighter economic future.

Real wages only rose by 0.7% annually in the three months to April (the most recent data).

Jeremy Cook, chief economist at the currency company World First, nails it:

“The inflation data will encourage those economists and rate watchers looking for a tightening of Bank of England monetary policy this year, but for those who are seeing below inflation wage increases, the situation just got a little more painful."

Women's clothing, food and air fares drove UK inflation to 1.9%

It looks as if inflation jumped because UK retailers did not offer such generous summer sales as usual in May.

The Office for National Statistics explains:

Clothing & footwear: prices, overall, rose by 0.6% between May and June this year compared with a fall of 1.9% a year ago. Prices usually fall between May and June as the summer sales begin but this year the average prices of a number of products have risen. The main upward effect came from garments, particularly women’s outerwear where there were upward contributions from nearly all items, the largest from trousers and skirts.

UK inflation data, to June 2014 Photograph: /ONS

Food prices also picked up month-on-month:

food & non-alcoholic beverages: prices, overall, rose between May and June this year but fell between the same two months a year ago. The upward effect came principally from vegetables, bread & cereals, sugar, jam, syrups, chocolate & confectionery and mineral waters, soft drinks & juices.

And air fares also rose between May and June:

transport: prices, overall, rose by 0.6% between May and June 2014, compared with a rise of 0.1% between the same two months a year earlier. The largest upward contribution came from air transport, with average fares rising this year but falling in 2013, particularly on European routes. There was also a smaller upward effect from sea transport. Partially offsetting these movements was a small downward contribution from motor fuels with prices, overall, rising this year by less than a year ago.

Last month’s CPI release fell to a 4 year low of 1.5% and further weakness would allow the Bank of England to lean on the lack of price pressures in a bid to keep monetary policy as loose as possible going forward.

Regulators propose changing the 4pm FX fix

The Financial Stability Board, chaired by Mark Carney, issued a range of recommendations this morning, following allegations that FX traders have conspired to rig the official currency rates.

Their recommendations include widening the "4pm fix" -- when the daily rates are taken in a snapshot -- and forcing banks to harden up their internal control systems to address potential conflicts of interest.

They say:

The group recommends the fixing window be widened from its current width of one minute. It seeks feedback from market participants as to the appropriate width of the calculation window.

It includes this chart, showing how 4pm London time is the busiest time of the day as traders try to make deals for their clients at the daily fix (there are allegations that some traders have shared information about big deals).

The euro-US dollar market - daily volume. Photograph: FSB

However, the most volatile time of the day is 1.30pm, when much US economic data is announced.

Its shares tumbled another 8% in early trading, close to their all-time low, as fears over the Espírito Santo group continue to swirl.

As regular readers know, the crisis at Espírito Santo International shook the markets last week, after the conglomerate delayed a debt repayment. The group, controlled by the Espírito Santo family, has also been investigated for accounting irregularities.

Banco Espírito Santo is partly controlled by the Espírito Santo family, whose main holding, Espírito Santo International SA, is in deep financial trouble. The bank has lent money to Espírito Santo International and sold the holding's debt to clients.

Inflation, Carney and Yellen in focus

Did UK inflation accelerate last month? We find out shortly.... Photograph: Alamy

Good morning, and welcome to our rolling coverage of the financial markets, the economy, business and the eurozone.

History, Simon Schama once explained, can come at you with a rush, knocking you down and wiping out your bearings. And today is one of those days when the news flow could sweep us off our feet too.

Two top central bankers have the stage – at 10am, the Bank of England governor, Mark Carney, will be quizzed by MPs over the latest financial stability report. Expect plenty of questions about the UK housing market, amid signs that the BoE's tougher talk is cooling prices.

And then at 3pm, Federal Reserve chair Janet Yellen begins testifying to Congress; the markets will be looking for hints on when the Fed might decide its safe to start raising interest rates.

Federal Reserve Chair Janet Yellen. Photograph: Susan Walsh/AP

The earning's season will also kick off in earnest, Johnson & Johnson, JP Morgan and Goldman Sachs all reporting their latest results before Wall Street opens (so around lunchtime UK time). That could give stock markets the impetus to drive even higher...

There's a flurry of economic news too.

The latest UK inflation data is due at 9.30am. It's expected to show that the cost of living rose at a faster rate in June, with the Consumer prices index rising to 1.6%, from 1.5% in May.

We also get the latest German ZEW Survey of economic sentiment at 10am -- showing if German firms have seen signs that Europe's latest economy is slowing down.

Plus the latest US retail sales and Empire manufacturing report, both at 1.30pm, showing if America's economy kept bouncing back from its winter chill.

And in the consumer world, Britain's payday lenders are being hauled into line – with the Financial Conduct Authority announcing new proposals to prevent consumers being stung. More on this shortly....

OK, it's not exactly the Norman Conquest, but it should keep us busy today....